It‘s the Same Old MO: Entice With Money, Then Foreclose

It’s deja vu all over again, as Yogi Berra would say. Another country that went down the road of debt accumulation just to pay for essential public services. Since Puerto Ricans are born American citizens, you’d think that Puerto Rico could just declare bankruptcy as Detroit, Birmingham, and San Bernardino did. But no, US law forbids that.

On May 2, a bond payment of $422 million was missed, and a $2 billion payment comes due in July. There’s no way Puerto Rico can pay. Puerto Rico is begging Congress for debt relief. But no debt relief is in sight.

Here are the facts: Puerto Rico is $70 billion in debt. 45% of the people live in poverty. The unemployment rate is over 12%.

Angry graffiti scrawled across the brightly colored buildings of San Juan tells the creditors of the world exactly where they can stick their plan to extract roughly $73 billion in debt from the struggling U.S. territory. “Puerto Rico comes first. To hell with the debt,” reads one wall. “Don’t play around with my retirement,” says the side of a major freeway. Down by the University of Puerto Rico, the walls and sidewalk are filled with laments — “Look into my unemployed face” — and calls to action: “Study and fight!”

Depending who you ask in Puerto Rico, the debt crisis was caused by neo-colonial and imperialist policies from the U.S., the Puerto Rican government’s wasteful overspending, and corruption, or the cadre of hedge funds that are currently profiting from the island’s woes. Add to that toxic mix a series of free-trade agreements that triggered mass outsourcing, and a population in rapid decline due to out-migration, and you arrive where we are today, with the government on the hook for tens of billions of dollars.

Unlike Greeks, Puerto Ricans have an out – simply pack up and leave for the United States. They’re American citizens after all. And that’s just what they’re doing – in droves. Doctors are leaving at the rate of one per day. Meanwhile, vulture hedge funds are buying up Puerto Rican debt at fire sale prices. Like Paul Singer did in Argentina, they will then demand repayment at full face value.

Meanwhile, unemployment skyrockets and almost half of the remaining islanders are living in poverty. How did it get this way? As usual, the US Congress and tax policy are at fault.

As a result of a 1976 tax reform, US pharmaceutical companies enjoyed a tax holiday on Puerto Rican corporate income and paid virtually no property taxes. Under this law, other US companies also received 100% exemption from municipal taxes in Puerto Rico, and pharmaceutical companies qualified for a special 5% payroll deduction. Corporations which located in Puerto Rico didn’t have to pay taxes to repatriate their profits as they do when profits are made in other countries.

Congress Made Puerto Rico an Offer It Couldn’t Refuse, Then Reneged

With the help of US tax incentives, the pharmaceutical industry accounted for as much as a quarter of the island’s gross domestic product with $36.5 billion in annual exports in 2007.

By the mid-1990s, critics led by Texas Representative Bill Archer, then the Republican chairman of the House Ways and Means Committee, attacked the break as too expensive, costing the U.S. about $3 billion a year. In some industries, the tax subsidy was costing the U.S. as much as $72,000 per job, according to a study by the federal agency now called the Government Accountability Office. After a lobbying battle in 1996, the tax break was repealed, with a 10-year transition period for companies already benefiting from the credit.

After making tax policy such that many businesses, especially pharmaceutical firms were attracted to the island, tax policy was reversed and they all moved out. In 1996, a section of the US Internal Revenue Code (Section 936), that provided for profits to be repatriated to the US without paying federal taxes, was repealed. Thus, the employment base had its legs cut out from under it.

So to keep public services comparable to what they had become accustomed to, the government started to borrow money from Wall Street. Predatory loan sharks that they are, they started making loans to Puerto Rico that they knew they couldn’t pay back just like they made mortgage loans prior to the US financial crisis of 2008 that they knew the mortgagees couldn’t pay back – liar loans they were called because people taking them out didn’t have to show any income. They could say their income was anything with absolutely no bank statements or other paperwork to back it up.

This whole scenario is known as debt deflation that we have written about before. No matter how much money is infused into Puerto Rico to enable it to meet payment deadlines on its bonds, there will never be enough money to pay back its loans because the money is just not there even to meet current expenses. They are insolvent.

Throwing good money after bad turns borrowing more into a Ponzi scheme. The only ones who can possibly benefit from this are the hedge funds which will demand that government assets should be privatized and sold off to them in lieu of repayments on the bonds they hold. This is exactly what happened in Greece and Argentina and in Detroit for that matter. Hedge funds said that, if Greece could not repay them when the bonds became due, they would take Greek assets such as the Parthenon and Athens ports and whatever else was a moneymaker.

What happened in Detroit was Disaster Capitalism at its most exemplary. An Emergency Manager was appointed to run the government thus taking “democracy” out of the hands of elected representatives. The same thing will probably happen in Puerto Rico after it’s declared insolvent by the bond markets which are all in a dither and all atwitter over Puerto Rico’s impending bankruptcy.

Oh, I forgot, Puerto Rico is not allowed to go bankrupt; that makes the situation even worse. Valuable assets will then just be extracted as Puerto Ricans either exit the island or fall on their knees and beg the bond markets for mercy.

The hedge funds may have more success in this strategy of asset seizing in Puerto Rico than they had in Greece because Puerto Rico is at the mercy of US lawmakers. Greece was not. The US Congress can just turn over Puerto Rican assets to rich investors, and they will take the good parts while leaving the rest to rot including the people who will not have the capability of reaching the mainland – the 45% in poverty.

Bond Markets Structure Who Gets Paid First and Who Waits in Line

The bond markets are wising up, though. The all important structuring of who gets paid first and who has to stand in line is being given more attention these days. Before the predatory loan making process proceeds, the recipient has to agree that bondholders will be paid back first even before essential services are provided. Puerto Rico is safe for now because the payments that are due immediately don’t have this provision so the government of Puerto Rico can and has made the decision to use what meager funds are at its disposal to pay for essential services and tell the bondholders to take a hike. That will not always be the case especially for future non-heeders of this cautionary tale. In the future bonds are structured in such a way that they must be paid back even before essential public services such as drinking water and hospitals can be paid for. This is from the New York Times:

But the bigger issue may be that second, larger debt bill due in July, roughly $800 million of which is constitutionally guaranteed, giving the payment of it legal priority even over the funding of essential public services, such as police patrols, ambulances or drinking water. Investors who hold the guaranteed debt say they are prepared to fight to enforce their legal rights, no matter how much it may shock and anger the island’s residents.

The cycle leading to the private accumulation of wealth by billionaire hedge fund owners has now become a well-worn path: predatory lending followed by insolvency of the debt, followed by the installation of a non-democratically elected Emergency Manager, followed by privatization of assets followed by the destruction of public services followed by the destruction of government itself, the proverbial drowning in the bathtub. Thus, all Puerto Ricans will have to eventually pay private corporations for drinking water, electricity, hospitals, education, roads and various other services that are now primarily supplied as public rights throughout the world. And workers will be at the mercy of no-unions-allowed private employers.

Thus, all Puerto Ricans will have to eventually pay private corporations for drinking water, electricity, hospitals, education, roads and various other services that are now primarily supplied as public rights throughout the world. And workers will be at the mercy of no-unions-allowed private employers.

There are several wrinkles to the Puerto Rico debacle that make its situation somewhat unique. Before bondholders and hedge funds got wise and demanded that they be repaid for their bonds even before essential services could be paid for (the structuring we mentioned earlier that sets up the order in which debts are to be repaid), hundreds of millions in bonds were bought from a Government Development Bank that resold them to Puerto Rican pension funds. So a default on those bonds would mean the bondholders would actually lose their money instead of being first in line to reclaim it.

Despite the power and importance of the Government Development Bank, its debts are not backed by any taxing power or constitutional guarantee. If it defaults on the looming $422 million payment, its creditors have little legal recourse. And much of the bank’s debt, in the form of municipal bonds, is held by more than 100 credit unions on the island — financial institutions that tend to serve mom-and-pop savers in Puerto Rico’s poor and remote communities.

“The island’s credit unions represent the nest egg of nearly 1,000,000 Puerto Rican families (one of every four Puerto Ricans) that trust their livelihood and savings in these financial institutions,” said the credit unions’ primary regulator in a statement released last year, when the sector held Government Development Bank debt with a face value of slightly more than $500 million, according to regulatory records. The regulator’s spokesman did not answer messages Thursday.

Historically, the credit unions were required to invest only in very safe assets. But in 2009 their regulators made an exception, allowing them to buy and hold riskier bonds, as long as the bonds were issued by some branch of the Puerto Rican government. The change gave the Government Development Bank a new way to raise money, by selling its bonds to the credit unions.

So what else is new? It always boils down to seizing the assets of a pension fund to pay current bills or to bolster hedge fund profits. Meanwhile average Puerto Ricans (if there are any left) suffer. Financial maneuvering and shenanigans abound, the result of which is always to make the rich richer and make beggars out of the poor.This is what the financialization of the economy has wrought.

Puerto Rico has already removed assets from its workers’ compensation pool and public pension system to pay bills, taken cash from low-priority bonds to make payments due on high-priority bonds, and extended a highway privatization, giving up future toll revenue (as Chicago did) in exchange for upfront payments of $115 million. So Puerto Rico is well on its way to becoming a private corporate owned haven for rich capitalists, a wholly owned subsidiary of the rich, who will profit from the booming tourist industry by building huge developments – hotels, condos and casinos which cater to the leisure travel class and the uber wealthy in this island paradise (for the rich).

John Lawrence

John Lawrence graduated from Georgia Tech, Stanford and University of California at San Diego. While at UCSD, he was one of the original writer/workers on the San Diego Free Press in the late 1960s. He founded the San Diego Jazz Society in 1984 which had grants from the San Diego Commission for Arts and Culture and presented both local and nationally known jazz artists. John received a Society of Professional Journalists, San Diego chapter, 2014 award. His website is Social Choice and Beyond which exemplifies his interest in Economic Democracy. His book is East West Synthesis. He also blogs at Will Blog For Food. He can be reached at j.c.lawrence@cox.net.